Wall Street gains accelerate as inflation begins to drop

Inflation data finally flipped, and investors also are looking to flip the script on the losses in equities from earlier in the year, with Wall Street picking up steam this week.

MANHATTAN (CN) — As inflation seems to have turned a corner, Wall Street hopes to improve on its summer gains and recoup losses from the spring.

U.S. indices posted meager gains early in the week, but on Wednesday investors pulled further ahead on news that headline inflation fell in July from 9.1% to 8.5%, according to data released by the federal government. By the week’s end, the Dow Jones Industrial Average gained 958 points, while the S&P 500 and Nasdaq put up 134 points and 390 points, respectively.

While the Consumer Price Index was unchanged in July, not something investors generally would cheer, the data were better than analyst expectations and indicate to some experts that inflation may have peaked or at least taken a breather. It also indicates the Federal Reserve may not remain as hawkish when it again meets to discuss interest rates later in the fall.

Diving more deeply into the numbers put out by the U.S. Bureau of Labor Statistics, some sectors still saw price increases in July, and the flatlining inflation was driven primarily by the 4.6% drop in energy prices that includes an 11% fall in fuel oil. Services that don’t include energy services increased by 0.4% in July, while food prices picked up by 1.3%.

However, shipping costs are down year over year, while supply bottlenecks are loosening up, and core prices gained only 0.2% month-over-month, the fifth straight month that those prices have slowed.

“One month doesn’t make a trend, but at least headline is coming down and core stopped going up,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance. “If we see future months’ data showing a decrease in inflation, then it will help markets see the end of the tunnel in terms of rate hikes.”

The fall in energy prices in particular has caught analysts’ eyes, with some saying if energy prices continue to decline that will mark the end of rising inflation altogether. A few analysts, such as Paul Ashworth, chief North American economist at Capital Economics, are even predicting prices will begin to come down.

Ashworth calls food prices “the next deflationary shoe to drop,” noting the recent collapse in agricultural crop prices, as well as the fall in dairy, egg, and chicken futures prices. He also pointed to the unwinding of the avian flu outbreak from the spring. “[T]his is not yet the meaningful decline in inflation the Fed is looking for,” Ashworth wrote in an investor’s note. “But it’s a start and we expect to see broader signs of easing price pressures soon.”

Inflation expectations also are falling, at least according to the Federal Reserve Bank of New York. The institution noted on Monday in its Survey of Consumer Expectations that three-year inflation expectations fell sharply in July from 3.6% to 3.2%. One-year expectations also dropped from 6.8% to 6.2% from June to July, the New York Fed found.

Expectations among consumers related to the most headline-grabbing items related to inflation — namely, gasoline and food — also fell notably over that period. Expectations of year-ahead price changes fell by 4.2% for gas to 1.5% while the expectations for food price gains dropped by 2.5%.

Headline inflation is sure to fall dramatically over the next year, but the tight labor market and the expected rise in rent will keep inflation a talking point and economic pressure for the foreseeable future, experts say.

Inflationary expectations also starting to temper. Earlier in the week, the National Federation of Independent Business reported that small business optimism finally increased in July — barely, from 89.5 to 89.9 — after it had hit the lowest point in nearly ten years. Also concerning is that more than one-third of owners said inflation was the single-most important problem facing their business, the highest level since the fourth quarter of 1979.  

“The uptick in small business sentiment was disappointingly small considering that gas prices fell in July and the stock market partially recovered from the first half of 2022’s selloff,” said Bill Adams, chief economist at Comerica Bank. “The extremely weak small business outlook is another reason to think a recession is somewhat more likely than not over the next year and a half.”

The Bureau of Labor Statistics also reported earlier in the week that producer prices are decelerating, falling 0.5% last month after increases of about 1% the following two months. This is the first drop in headline producer prices since April 2020, and the 1.8% decline in final demand goods is the largest decline since that same month.

Once again, energy prices led the charge, posting a 9% decline in July, according to the producer price index, while food prices continued to increase, last month to the tune of 1%.

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